R&D Tax Credits : The Era of the Suckling Pig

Many readers have picked up on my disdain for the R&D tax incentive system in Australia and its role in propagating the mediocrity of our micro-cap public companies, particularly in the bioscience sector. When it comes to encouraging small, innovation-led enterprises to flourish, the general guidance for governments based on success stories around the globe, is “keep it simple and stay out of the way.”

This message somehow hasn’t reached our politicians.

Australia’s success as an innovator suffers mightily from the government’s inability to make basic structural reforms, reforms that frankly don’t hit the treasury in any particularly dramatic or upsetting fashion. Up-front taxation on employee incentive schemes is one shining example of where our policy makers simply illustrate how clueless they are about business and entrepreneurship, and the wheels have been spinning for literally decades on this issue. Another example is the fragmented and fractured distribution of early commercialisation incentive schemes that are not only hard to navigate, and bloated by public service “oversight”, but are needlessly bureaucratic to access. The government should want entrepreneurs running their companies, not filling out tortuous paperwork.

However, when I am asked what I think is the #1 biggest contributing policy disaster behind our mediocre bioscience landscape, my answer is the R&D tax incentive scheme. People get really upset when I say this, but it’s true, and I strongly believe it needs a re-think. When you look at the number of crap ASX-listed companies waiting for their tax rebate as a means of survival, this tells you everything you need to know. I’m not saying that we shouldn’t have R&D tax incentives, we should, I’m saying that the incentive should be directed more carefully with a view to industrial recruitment and economic diversification.

Not propping the balance sheet of poor quality companies. What is a poor quality company? A poor quality company is, quite simply, a company that would fail without the incentive.

My personal opinion is that ASX-listed micro-cap companies that currently meet the turnover threshold test for tax incentive refunds should be ineligible for this refund. Why? Because they have chosen to tap the public purse for financing by virtue of being listed. The access to tax incentives just means that management takes a chronically underfunded view of the financial resources needed to sustain the business, and instead of dedicating resources to develop the commercial and product “engine” of a company, resources are dedicated to “achieve” a sufficiently large tax refund and keep the gravy train running for a little while longer at taxpayer’s expense.

There are companies in the “Long Tail” of the ASX that actually go into periods of stasis and do nothing while waiting for R&D tax credits, cutting burn, reducing their competitiveness and prolonging product development timelines. I think private companies that intrinsically have less access to capital should still remain eligible, but public companies have other financing options and their cost of capital is lower.

Accumulated tax losses as offset against future product/service revenues – yes. Incentive refund – no.

My personal opinion is that the best thing that could ever happen to the ASX biosciences sector would be for the government to make listed small-cap companies ineligible because a lot of unsustainable and marginal businesses would simply fail. This in turn would provide greater clarity around which businesses are more deserving recipients of public capital and would actually boost the enthusiasm for the sector as an investment proposition because the average (remaining) quality would improve. It would be a short-term shock, but it would be a long-term gain.

Like all evolutionary pathways, sometimes a bit of Darwinian selection is a good thing.


 

The piggy image is licensed under the Creative Commons Attribution 2.5 Generic license. Source : A New Theory for the Evolution of Genomic Imprinting. Gross L, PLoS Biology Vol. 4/12/2006, e421.

15 thoughts on “R&D Tax Credits : The Era of the Suckling Pig

  1. Nice post and blog – appreciate how you have explained things for the layman.

    Btw Do you have an overview or know a good book on the different policies the government has in place to encourage R&D and commercialization in Australia? Also, could you comment on the culture surrounding R&D and industrial-academic collaboration in Australia? Thanks for your trouble in advance.

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  2. Thanks for writing this piece Chris and look forward to your further writings. And I had meant to thank Marc on another thread for his very good response to my question when I asked about the R+D tax incentives.

    Taking up where Marc left off. It appears that the R+D tax incentives seemed like a good idea in the early 2000’s. But less so now it is known how crappy companies are at this end of the market.

    So then why is it continuing?

    According to the 2013 Commission of Audit government research and development support is about:

    $3b to universities
    $2b through NHMRC, CRCs etc
    $2b to public research agencies (CSIRO etc)
    $2b to the private sector through the R+D tax incentive program.

    Marc may know how much of that $2b goes to biotech companies in the Long tail. I’m going to have a wild stab in the dark and say ballpark 100 biotechs receiving on average $1m each. So $100m.

    Its not a huge amount of money. But I’m pretty sure that it causes much more harm than good; and makes us dumber not smarter.

    This is because the market distortion and misallocation of funds it causes is amplified through inadequate regulation and lack of transparency at this end of the market. In other words the $100m of taxpayer funds is leveraged through pumps and dumps to suck many times that amount of money out of the market.

    The quantum of this problem is now such that it is having a noticeable corrupting influence. This is reflected in our universities where clever professors are now working on researching essentially scam health treatments. At its final endpoint the CEO and research scientists can decide to skip the research bit altogether and just claim the money for bogus research.

    As three scientists (including the CEO) currently in prison decided to do. And to be honest I have a bit of sympathy with their plight. Scientists are clever people. Deep down they would have known things like POHs fat cream was nonsense. Why bother actually slaving away on a bench top on this stuff when others on the POH gravy train by virture of their better connections (ie large share holdings acquired for nicks in the spin out of the company) were living the high life.

    I would be inclined to make it all up as well. The sentencing judge in this case commented about the discrepancy between university pay scales compared with the very lucrative life that could be achieved on the zombie biotech gravy train.

    In the early 2000s Medec (MAA), a small Perth micro-cap with an interest for energy medicine unveiled its state of the art foot detox bath. Foot detox baths are a well known scam but this one had a twist. It could be used for dogs. A clever country does not use taxpayer money to fund the development of doggy paw detox baths. Its that simple.

    Doggy Foot Bath

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  3. Disclaimer – I am currently employed doing R&D Tax work.

    Chris while I can understand your disdain for the R&D Tax Incentive, given that it appears to be providing a lifeline to some truly awful companies, I am disappointed that you have smoked up that number of $250M without any of your usually rigorous analysis.
    Some basic numbers:
    1. The Govt spent approx. $2.57 Billion for the 2012/13 tax year (more on this below).
    2. Of this, approx. 75% goes to companies with a turnover >$20 M.
    3. There were around 1,850 such claimants.
    4. This leaves somewhere just north of 10,000 claimants whose turnover was <$20M, who between them shared out around $642.5M.
    5. Just now my rudimentary excel skills detected 71 asx-listed companies in the sector Health Care Equipment & Services and 72 – CSL is excluded – in the sector Pharmaceuticals & Biotechnology (i.e. a total of 143, not all of whom are candidates for a starring role in the long tail either) which assuming an equal number of relevant entities for 2012/13 leads to a total of $9.81M. This estimate will significantly under-call the true amount as it is not taking into consideration the number of small tech firms (most applicants for the R&D Tax Incentive are engineers) who are claiming an R&D spend of <$50K. I'd split the difference between the $9M and Southoz's $100M, unless someone wants to do the analysis properly. (Should be straightforward: the size of my R&D Tax offset makes for a great price-sensitive announcement).

    Yes dodgy biotechs take advantage of the scheme. So do dodgy junior miners. But you shouldn't let that distract you from the fact that the R&D Tax Incentive is essentially the only Govt. support for business expenditure on R&D that exists, as well as covering a significant lack of VC capital. Nor to mention that the ATO actually recoups a large amount of the cost through foregone franking credits. Funnily enough they don't publicise how much, but that's another matter.

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    • Sorry I missed the ‘more on this below’. Numbers are a good couple of years behind and also don’t take into account that if a taxpayer has lodged a tax return with without claiming the R&D Tax Incentive but do have a registration they have up to five years to amend their return. Haven’t been able to find accurate numbers on this, nor on the foregone franking credits.

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    • I appreciate that you are in the space, and that counts a lot for me in terms of expertise (thanks for disclosing by the way). I am quite happy to defer to your position. However, your numbers don’t gel with my back-of-the-envelop numbers. I’m seeing in the 100-odd “Long Tail” companies (bio/med/services/health IT/specialty chemicals/materials) average R&D incentive rebates of ~$2m-odd. Help me to reconcile the gap?

      If you look at what ASX biotech/pharma companies claim as R&D tax incentive reimbursement relative to burn rate / SG&A, I can promise you it is not a few engineer/scientist salaries. I will bet you a good bottle of scotch (I am good for it) that if you go through the whole “eligible” sector, you will find easily $150m if not $200m in incentive refunds. NONE of the long-tail companies have turnover so the are all eligible. Pretty much Starpharma (who got $5m last year alone which pretty much kills your $9.81m) down.

      VC capital is private sector, not public. There is no “cannibalisation” of that incentive proposed in my commentary. As for what “line” this sits in the treasury “P&L”, I suspect it is moot. I agree.

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      • Yes I knew my $9.8M was an undercall which is why I split the difference between that number and $100M. Of more significance, if 100 companies really are claiming a third of the refundable offset, with 9,900 claiming the other two thirds, then the statistical profiling that is undertaken would have to trigger some significant regulatory activity. Currently the cases that are making court are still in the realms of the pre 1 July 2011 Tax Concession, so watch that space…

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      • Fair enough – but we can probably also agree that another $50-100m in more “added value” bioscience investment or funding certainly wouldn’t hurt.

        Great input into the discussion. Thanks!

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  4. A perspective on R&D and tax incentives revolves around their role in attracting innovative people and companies to nations/regions and attracting co-funding from other (often international) investment sources.

    The reasons for this type of policy mechanism are not always what they seem and can sometimes revolve around inter-nation competition, or just plain voter bargaining. Their actual effects in the marketplace need careful analysis as has been suggested here. Policies that target competitive environments between nations often have adverse unanticipated consequences at the coal face. It is possible that these unanticipated consequences are particularly evident in biotech (especially human biotech) due to the long tail. A policy is often analysed for effect to three out-years to ensure compatibility with an election cycle.

    From an economic standpoint, we would need to understand the costs and benefits to the macro economy, and not just the individual businesses or industry. From a company standpoint we would need to understand whether the integrity of the investment proposition is enhanced or degraded through interaction with the policy mechanism. It may look quite different at the macroeconomic level, than it does at the microeconomic level. I know this is an unfortunate statement, but from a macroeconomic perspective the net gain from Government R&D incentives may be high, at the same time as the loss to individual investors is high. If the macroeconomic gain is high enough, government will comfortably support individual losses. As long as the net benefit moves upward.

    One further thought. Sometimes the policy mechanism is theoretically sound, but is manipulated by market insiders to distort benefits.

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    • I agree with most of what you have written, noting that I said that a smarter “industrial recruitment” focus is required. I don’t have any problems with using tax incentives to lure companies to Australia to do business, so long as there is a commensurate investment and commitment to job creation… and a pragmatic understanding that when better incentives are offered somewhere else (i.e. Singapore) those companies will probably move again.

      We need to be smart enough to differentiate those kinds of policy objectives from systemic defects.

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  5. Pingback: Imugene’s big raise | The Long Tail

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